Pricing too low

Pricing right is one of the most tricky questions early-to-midstage startups face. On the one hand, you want to be cheap enough to make it a “no brainer” decision for your customers to adopt your product. But on the other hand, you want to make sure you are not leaving too much money on the table. Most of the startups I meet (and especially the Israeli ones) tend to fall into the first category of pricing too low.

When you tell an investor that your product is not only much faster/stronger/feature-rich/easier-to-use/robust/modern than competition but is also much cheaper- it raises a red flag. If your product is so much better than other alternatives, then why do you have to sell it for less? Wouldn’t the customer be willing to pay at least the same amount as competition for a much better product? Moreover, we all know this natural tendency to determine how much something is worth by its price: When you buy a $100 wine bottle you feel great opening it for your anniversary, yet if someone will offer you the same bottle for $15, suddenly it wouldn’t feel so lucrative anymore. The same thought process goes in the mind of your customer when your product is just too cheap.

Many times the reason startups fall into the trap of undercutting price is that they start by pricing very low to get early adoption. Later on they either have a problem raising prices since they are visible and it will cause a backlash or the entrepreneurs have already anchored their own mindset to a price that now seems “normal” and find it hard to raise it substantially. Basically, the company is sacrificing its long term value on expense of some short term gains.

So, how do you avoid this? There are a few things you might want to consider here:

1. Price elasticity – similar to Econ 101 you want to make sure that you optimize based on the price/volume demand curve. While this may seem very obvious, too many times I see companies that never think of this. For example, I recently saw a startup that offers customers a discount for buying multiple services in advance. The company was excited that the large majority of their customers elected to do so, seeing this as an act of confidence in their service. While flattering, the company would have probably monetized better if it had reduced the pre-pay discount as there is clearly a high willingness to pay.

2. Aggressiveness – don’t be afraid to be aggressive. Especially if you can demonstrate a clear and visible ROI. You should aim to capture a meaningful portion of it instead of giving it away to your customers. The better your product is – the more you should charge for it (again, this may seem obvious but too often startups want to be better AND cheaper). Some of the best B2B companies I saw understood the value of their product and were extremely aggressive on pricing, knowing that their customers will still be glad to pay.

3. Dynamic pricing- find a pricing scheme that lets your customers start using your initial product cheaply, but as it improves – the price increases as well. For example, a caching provider can price based on the total amount of data cached instead of pricing based on the the amount of caches deployed. As the algorithms get better the hit rate will increase and each cache will become more efficient and therefore – more expensive.

4. Consider ditching your pricing page – while counter-intuitive, it’s not always good to be transparent with pricing. Not having full pricing transparency allows you to have more flexibility in determining prices and matching price to the perceived value each customer has. In fact, a McKinsey study for SaaS companies revealed that companies with less pricing transparency tend to grow faster:

Less-Transparency-ACV source: McKinsey

5. Smart pricing tiers- As you add features consider adding more pricing tiers in a way that will “naturally”  gravitate your customers towards the higher tiers. Try to name your tiers with logical names like “SMB”, “Professional”, “Freelancer” etc. instead of “gold”, “silver” and “bronze”. This will help ensure not everyone picks the middle option.

There are many more levers you can play with to optimize pricing. The key is to be creative and proactive not get “stuck” with a semi-random price you set when you first launched the company.

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